Two of Three Conservation Easements Did Not Give Rise to Charitable Deductions

(Parker Tax Publishing January 2019)

The Tax Court held that (1) two easement donations by a partnership did not restrict a specific, identifiable piece of real property because the easements allowed supposedly conserved land to be taken back and used for residential development and, thus, neither easement constituted a qualified real property interest that could give rise to a charitable contribution deduction under Code Sec. 170(h)(1)(A), and (2) a third easement donation by the partnership did give rise to a charitable deduction because it covered a specific, identifiable piece of real property, was granted in perpetuity, was made exclusively for conservation purposes, and constituted a qualified real property interest. Pine Mountain Preserve, LLLP v. Comm'r, 151 T.C. No. 4 (2018); Pine Mountain Preserve LLLP v. Comm'r, T.C. Memo. 2018-214.

Background

In 2004, Douglas Eddleman and his father began acquiring undeveloped land near Birmingham, Alabama. The Eddlemans eventually purchased 10 contiguous parcels covering approximately 6,200 acres, referred to as the Pine Mountain property. The Eddlemans formed a partnership, Pine Mountain Preserve, LLLP (PMP), to hold and develop the property.

PMP conveyed three conservation easements - the 2005, 2006 and 2007 easements - to the North American Land Trust (NALT), a qualified organization under Code Sec. 170(h)(3). Each easement defined a conservation area that was to be restricted in perpetuity from commercial and residential development. However, the 2005 and 2006 easements carved out 16 reserved "building areas," also referred to as "homesites," within each of which PMP could construct a single family residence and appurtenant structures.

The 2005 easement reserved to PMP or an individual homeowner the right to build one single family dwelling within each of ten building areas inside the conservation area. Each building area could also include a shed, garage, gazebo, vehicle parking area, and pool, as well as other facilities appurtenant to residential development, such as barns, riding stables, scenic overlooks, and boat storage buildings. The 2005 easement provided that the boundaries of the building areas could be modified by mutual agreement of PMP and NALT.

The 2006 easement did not specify the locations of the building areas, and placed no limitations on where they could be located except to state that they had to be approved in advance by NALT. The 2006 easement also allowed PMP to build a water tower within the conservation area and underground pipelines from it to provide water service to the building areas.

The 2007 easement designated no building areas, and permitted no residential construction anywhere within the conservation area. It likewise reserved to PMP no rights to construct scenic overlooks, riding stables, ponds, boat storage buildings, or piers. The 2007 easement, like the other easements, contained a provision giving PMP and NALT the right to mutually agree to amendments of the easement which were not inconsistent with the conservation purposes.

On its Forms 1065 for 2005-2007, PMP claimed charitable contribution deductions of approximately $16,500,000, $12,700,000, and $4,100,000, respectively for its donation of the easements. With each return, PMP included an appraisal and a Form 8283, Noncash Charitable Contributions, executed by the appraiser and the president of NALT.

The IRS audited PMP's returns and, in 2013, issued final partnership administrative adjustments (FPAAs) for each year to PMP's tax matters partner. The FPAAs disallowed the charitable contribution deductions for the three easements in their entirety, determining that requirements under Code Sec. 170 had not been met. In the alternative, the FPAAs determined that the value of the contributed properties had not been established. PMP challenged the FPAAs in the Tax Court.

Analysis

For contributions of property other than money, the amount of the contribution deduction is generally the fair market value of the property at the time the contribution is made. In general, no deduction is allowed for the contribution of a partial interest in property. An exception applies, however, under Code Sec. 170(f)(3)(B)(iii) for a qualified conservation contribution. Code Sec. 170(h)(1) provides that this exception applies where the taxpayer contributes a "qualified real property interest," as defined in Code Sec. 170(h)(2)(C), to a qualified donee and the contribution is exclusively for conservation purposes. The issue in this case was whether the easements were qualified real property interests.

Under Code Sec. 170(h)(2)(C), a qualified real property interest includes "a restriction (granted in perpetuity) on the use which may be made of the real property." In Belk v. Comm'r, 140 T.C. 1 (2013), aff'd 2014 PTC 614 (4th Cir. 2014), the Tax Court held that where an easement permitted the parties to change what real property was subject to the conservation easement, Code Sec. 170(h)(2)(C) precluded the deduction because the taxpayers did not donate an interest in real property subject to a use restriction granted in perpetuity.

However, in Bosque Canyon Ranch, LP., 2017 PTC 367 (5th Cir. 2017), the Fifth Circuit vacated and remanded a Tax Court decision which relied in part on Belk, holding that easements which allowed the developer only to modify the location of homesite parcels within the conservation area, but not the exterior boundaries of the conservation area, satisfied the perpetuity requirement. The Fifth Circuit cited the need for flexibility to address changing or unforeseen conditions and found that any potential tweaking of the homesite boundaries could not detract from the conservation purposes for which the easement was granted. In a dissenting opinion, one judge explained that the modification provision in the easement expressly permitted the substitution of unprotected land for land that was originally protected by the easement, thus changing what real property was subject to the easement; the dissenting judge therefore concluded that the easement did not constitute a qualified conservation contribution.

In the present case, the IRS argued that, as in Belk, the easements did not constitute qualified real property interests because the use restrictions were not granted in perpetuity. According to the IRS, the reserved rights in the easements allowed PMP to take back supposedly conserved land and dedicate it to residential development, which could consist of up to 16 single family residences and other structures intended for the homeowners' recreation and enjoyment. With respect to the 2007 easement, the IRS argued that the amendment provision violated the perpetuity requirement because, for example, the parties could mutually agree to reduce the size of the conservation area.

The Tax Court agreed with the IRS as to the 2005 and 2006 easements, but upheld the deductibility of the 2007 easement. The court explained that the case was appealable to the Eleventh Circuit, which it found had not ruled on the issue, so the Tax Court was not bound to follow the Fifth Circuit's holding in Bosque Ranch. Instead, the Tax Court found that the Fourth Circuit's analysis in Belk was correct and agreed with the dissenting judge in Bosque Canyon.

The Tax Court first addressed the 2006 easement. It found that nowhere in the deed or in the plat were the locations of the building areas specified, nor were any limitations placed on where within the conservation area such buildings could be located other than to say that they had to be approved in advance by NALT. In the Tax Court's view, the restriction in the 2006 easement was perpetual but the restriction on the real property was not; the easement did not, when granted, create a perpetual use restriction on a defined parcel of land as required by Code Sec. 170(h)(2)(C).

The 2005 easement failed, according to the Tax Court, because not only did it allow the relocation of homesites, it also permitted PMP to build within the conservation area other structures and facilities appurtenant to the residential development. The court found that, as in Bosque Canyon, the 2005 easement put no limits on how many homesites could be moved, how often this could be done, or how far into the future such relocations could occur. The ability of PMP to construct other buildings had the collective effect, in the court's view, of expanding the residential development well beyond the ten acres of the building areas.

The Tax Court found that the 2007 easement, unlike the other two, constituted a qualified real property interest because it designated no building areas, permitted no residential construction anywhere within the conservation area, and did not permit PMP to build structures appurtenant to residential development. While the 2007 easement did permit the construction of a water tower and underground pipes, the court concluded that this had no effect on whether the use restriction attached in perpetuity to a defined parcel of real property. The court also rejected the IRS's argument that the amendment provision violated the perpetuity requirement because, in the court's view, it was hard to imagine how NALT could conscientiously find such an amendment to be consistent with the easement's conservation purposes, and both the Tax Court and the Courts of Appeals had previously rejected similar arguments.

The Tax Court addressed the valuation of the 2007 easement in a separate opinion and held that the value of the 2007 easement was $4,779,500. The court concluded that neither PMP's nor the IRS's valuation experts used a valuation method that fit within the valuation parameters of Reg. Sec. 1.170A-14(h)(3)(i), and thus, the court gave equal weight to the values assigned by both sides.

For a discussion of the rules for contributions of partial interests in property, see Parker Tax ¶84,155.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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